Euro falls to new low; Seen headed toward parity with the dollar

CBS.MarketWatch.com

LONDON (CBS.MW) -- The euro fell to a new low against the dollar Monday as investors worried that the escalating Yugoslav conflict will take its toll on Europe's already-struggling economy in the months ahead.

Until recently, investors have turned a blithe eye to the NATO bombings in the Baltic region -- choosing to believe that the war there will be relatively short-lived as it was when British and U.S. forces struck Iraq last year. But war rhetoric has been hardening by the hour, with fresh reports of NATO bombings on the Belgrade capital and a growing belief that NATO ground troops may be deployed.

As the day progressed, the euro slipped further, falling at one point to its lowest level yet of $1.0594. This has raised the previously little-discussed prospect of the single currency cruising toward parity with the U.S. dollar from its Jan. 4 launch of $1.6675. Such talk would have been sacrilegious three months back.

But euro's fall from grace, more recently, reflects concerns that a prolonged war in Yugoslavia will cause certain eurozone country budget deficits to swell past levels permitted in the 1993 Treaty of Maastricht.

The European Central Bank warned Friday in its annual report that certain unnamed countries are already dangerously close to breaching accepted deficit levels under Maastricht. All of this sounds worrying, at least theoretically. So why isn't anyone worried besides those who are dumping euros for dollars?

Consider, for instance, that as the euro lost its shirt Monday, London's benchmark index, the FTSE 100, finished at a record high while Germany surged 2 percent and France 1.8 percent. Even Wim Duisenberg, the European Central Bank's president, said the euro slide was no big deal as he spoke before the European Parliament on Monday.

"Nobody who has authority in Europe is doing anything. If they [the ECB] were bothered then they'd be talking the euro higher," said Ian Gunner, foreign exchange strategist at ABN Amro in London. He said the euro/dollar has become less important to the ECB than the deutsche mark/dollar level ever was to Germany's central bank, the Bundesbank, before the euro came on the scene.

A smaller world

There's a reason for this. Before the European Monetary Union, the gross domestic product (GDP) as a percent of trade for economies such as Germany averaged 30 percent. Since the EMU, the overall dependence of the eurozone's GDP on trade has shrunk to near 11 percent.

Still, the euro selloff clearly seems to be a sign that someone out there's worried about Europe. So why, if the euro is viewed as an economic barometer for investor sentiment in the region -- aren't equity investors more worried about Yugoslavia? Data: International Indexes

For one thing, it's a lot easier to sell the euro than it is to re-adjust entire equity portfolios to factor in the risk of war -- especially when it's far from clear as yet how long the war will last. At this point equity investors may find it more of a risk to change their longer-term strategy than to hedge their bets for the time being.

"If you're a portfolio holder you may be holding a whole range of equities; it's a more significant task [to rebalance that portfolio] than to tell your currency broker to sell euros," said Stephen Hannah, chief economist at IBJ International in London. "So the currency will take the brunt of the risk premium. The cost of taking that view is that the spread is so much narrower for currency sellers," he added.

There's that, and the reality that European equities have already been underperfoming the U.S. market. One of the reasons investment guru Warren Buffett has recently showed up in London with lots of cash. He's been leaving markets guessing over just what he's buying. This guessing game has been helping stocks such as downtrodden Marks & Spencer
maspy-bbSee related story.

Who cares?

Meanwhile, the euro's misfortunes are in some cases the blessing of European companies, as it makes their goods more competitive overseas. Add to this the ECB's recent 50 basis-point rate cut -- which on average cut the cost of capital by some 17 percent in the eurozone -- and equities are basically feeling little pain at the moment.

So where does this leave the euro? As far as the ECB and most other economists are concerned, the answer seems to be "who cares?" Forget the dearly-held visions of kicking the stuffing out of the dollar; these days benign neglect is the buzzword.

"It's not so desperate if the euro reaches dollar parity," IBJ's Hannah said. Besides, he reasons, there's nothing much the ECB can do to make a difference anyway. And the ECB knows it.

"The euro is quite cheap, but I can understand that with the Kosovo phenomena and the new potential for shocks there. But there's nothing the ECB can do; intervention isn't going to work. It could blow up in their face," he added.

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